Hugo Dixon: Battle against Grexit far from won

The battle against Grexit - Greece’s exit from the euro - is far from won. Assume Athens is promised its next 44 billion euro tranche of bailout cash and some further debt relief when euro zone finance ministers reconvene on Nov. 26. Even then, the banks will still be hobbled, while another round of austerity is in the works and vested interests are rife.

It will be hard to restore confidence and, without that, there won’t be a return to growth. Meanwhile, without growth, Antonis Samaras’ fragile coalition government will fall. Alexis Tsipras’ radical left SYRIZA movement would then probably take over - plunging the country into a new hot phase of the crisis. What’s more, if investors and consumers fear such a scenario, they won’t start spending - making a continuation of the slump self-fulfilling.

Samaras, who became prime minister in June, has been better than many feared. His strategy has been to do everything demanded of Greece by the “Troika” - the European Commission, the European Central Bank and the International Monetary Fund - with the aim of changing the perception that Athens cannot be trusted.

The prime minister had to make up a lot of lost ground: partly because of mistakes made by George Papandreou’s government; and partly because Samaras himself was unwilling to get behind the reform programme when he was in opposition and then brought Loukas Papademos’ technocratic administration to a premature end. The last year’s shenanigans - Papandreou’s aborted referendum followed by two destabilising elections - have savaged Greece’s credibility.

That said, Greece’s recent “good behaviour” looks like being rewarded by a cash injection and some debt relief. That will undoubtedly be good news - giving a new chance to the country, where I spent much of last week. But it probably won’t be big enough.

Most attention has focused on the fact that Athens’ debt will still be unsustainable because Angela Merkel is unwilling to countenance a writedown of loans to Greece before next year’s German elections - and that this will act as a drag on confidence and investment. But a failure to make the banking system sustainable is potentially an even bigger problem.

Most of the 44 billion euros in new cash will be used to recapitalise the banks. When that is added to bridge capital provided during the summer, the system will have received 48 billion euros in total. Although this amounts to a quarter of Greece’s GDP, it probably won’t be enough to handle two mega problems: the banks’ vast portfolio of Greek government bonds which have undergone a haircut and will have to be written down again; and an avalanche of non-performing loans to the private sector caused by the depression.

Since the 48 billion euro figure was calculated last year, admittedly with a buffer, the economic outlook has deteriorated. The European Commission, for example, expects GDP to be about 10 percent less at the end of 2013 than it did a year ago.

Nobody, though, seems to want to look at the possibility that the banks will be undercapitalised - presumably because they haven’t got a clue about how to raise the extra money. Nor does anybody seem to be looking to create a “bad bank” to take over the viable banks’ dud loans. Such a scheme - which is being used in Ireland and Spain - is a tried and tested mechanism to free banks from the past and so allow them to fund an economic recovery.

The financial system’s probable capital inadequacy isn’t its only problem. The banks are also still relying on the ECB and the Bank of Greece for about 135 billion euros in funding, after wholesale markets stopped financing them and many savers took out their deposits. Banks will have a strong incentive to repay these loans. So, all in all, they are unlikely to pump much liquidity into the economy.

The next tranche of bailout cash will also be used to repay the government’s unpaid bills - which stand at about 8 billion euros. But this will be swamped by the latest 13.5 billion euro fiscal squeeze.

Meanwhile, Greece still needs to restore its competitiveness. The good news is that labour costs are collapsing and the current account deficit is shrinking - partly because of labour reforms and partly because of the brute force of depression. The bad news is that prices haven’t yet dropped because the country’s vested interests are exploiting their positions to hang onto excess profits.

Given all this, the Greek economy - which has slumped 20 percent since the end of 2008 - will shrink again next year. The government should be able to survive that, even if rising social unrest buoys SYRIZA and the neo-fascist Golden Dawn party. The real problem will occur if the economy continues to contract into 2014.

To some extent, the outcome is outside Samaras’ control. But his best chance is to win brownie points with the Troika by a determined onslaught on corruption, cartels and tax evasion. Greece may then eventually be rewarded with a bigger debt writedown, more cash to recapitalise its banks and a more efficient economy. There will also be less risk that it will be forced into another round of austerity.

It is unclear whether Samaras has the courage to confront the country’s business lobbies, many of whom are supporters of his conservative New Democracy party. But doing so would give him a claim to a place in the history books.

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Euro zone finance ministers and the International Monetary Fund will seek to unfreeze the next 44 billion euro tranche of aid to Greece on Nov. 26, and try to work out a plan to make the country’s debt sustainable.

Euro zone ministers and their deputies have held several meetings and conference calls over the last two weeks to decide how Greek debt, expected to reach 190 percent of GDP next year, could be cut to 120 percent in 8-10 years.

French Finance Minister Pierre Moscovici told BMF radio on Nov. 25 possible solutions included lowering interest rates on Greece’s loans and getting central banks to give up profit made from trading its debt.

“We will probably have to use to all these solutions at the same time so that the (debt) programme is financed from now until 2016 and for the debt to be sustainable until 2020, which will mark perhaps a stage, with an extension until 2022,” he said.